Riskless Principal

Definition of 'Riskless Principal'


A trade in a security that involves two orders, with the execution of one of these orders dependent upon the receipt or execution of the other. Riskless principal is defined by the Financial Industry Regulatory Authority (FINRA) as a trade in which a member who has received a customer order immediately executes an identical order in the marketplace, while taking on the role of principal, in order to fill the customer order.

A buy order from a customer would therefore require the member firm to execute an identical buy order in the market as principal, while a sell order would require the member firm to execute an identical sell order in the market. In order to qualify for riskless principal trades, FINRA stipulates that the trades should be executed at the same price, exclusive of a markup/markdown, commission or other fees.

Investopedia explains 'Riskless Principal'


For example, a broker-dealer who is a FINRA member and receives a customer order to buy 10,000 shares of Widget Co. at the prevailing market price of $10 would immediately buy the 10,000 shares from another member at $10. Since both trades were executed at the same price (excluding commissions), this would qualify as a riskless principal transaction.

On March 24, 1999, the SEC approved amendments to FINRA, then the National Association of Security Dealers (NASD) rules regarding the reporting of riskless principal transactions by market makers in Nasdaq and OTC securities. The rule change, which was effective Sep. 30, 1999, permitted market makers to only report one leg of a riskless principal transaction, rather than both legs, as was the requirement previously.

While market makers are always deemed to be "at risk" when trading from their principal accounts, the amendment was an acknowledgment of the fact that trades undertaken to offset customer orders are riskless. One of the significant benefits of this rule change was a reduction in transaction fees levied by the SEC.



comments powered by Disqus
Hot Definitions
  1. Yield Burning

    The illegal practice of underwriters marking up the prices on bonds for the purpose of reducing the yield on the bond. This practice, referred to as "burning the yield," is done after the bond is placed in escrow for an investor who is awaiting repayment.
  2. Marginal Analysis

    An examination of the additional benefits of an activity compared to the additional costs of that activity. Companies use marginal analysis as a decision-making tool to help them maximize their profits. Individuals unconsciously use marginal analysis to make a host of everyday decisions. Marginal analysis is also widely used in microeconomics when analyzing how a complex system is affected by marginal manipulation of its comprising variables.
  3. Treasury Inflation Protected Securities - TIPS

    A treasury security that is indexed to inflation in order to protect investors from the negative effects of inflation. TIPS are considered an extremely low-risk investment since they are backed by the U.S. government and since their par value rises with inflation, as measured by the Consumer Price Index, while their interest rate remains fixed.
  4. Gilt-Edged Switching

    The selling and repurchasing of certain high-grade stocks or bonds to capture profits. Gilt-edged switching involves gilt-edged security, which can be high-grade stock or bond issued by a financially stable company such as the Blue Chip companies or by certain governments.
  5. Master Limited Partnership - MLP

    A type of limited partnership that is publicly traded. There are two types of partners in this type of partnership: The limited partner is the person or group that provides the capital to the MLP and receives periodic income distributions from the MLP's cash flow, whereas the general partner is the party responsible for managing the MLP's affairs and receives compensation that is linked to the performance of the venture.
  6. Class Action

    An action where an individual represents a group in a court claim. The judgment from the suit is for all the members of the group (class).
Trading Center